Saturday, 27 July 2013

What do we care about today? (27 July 2013)

US equity markets staged an impressive intra-day comeback on Friday night to close just above breakeven for the session. The S&P500 was down -0.8% at the low but closed +0.1% while the Dow closed more than 100 points off its lows.

Of the 260 companies of the S&P that have posted 2Q results so far, 73% have beaten earnings estimates while 57% have beaten revenue projections. This shows the majority of beats continue to come from improved efficiencies, lower expenses and lower interest costs rather than improving end demand.

Hopefully this will change, if the University of Michigan Index of Consumer Sentiment is any indication. The index unexpectedly advanced to 85.1 in July from 84.1 in June to reach its highest level in 6 years. This index is finally out of recessionary territory and now back in "normal" territory.

Arguably of greater importance is forward earnings revisions. So far in July, S&P500 upward earnings estimate revisions ticked up to 49.8%, up from 48.3% in June. So far earnings season has been ok but not stellar...and this is against pretty low expectations.

One of my "pet" tech stocks, Activision Blizzard, gained +15% after agreeing to buy back most of the stock Vivendi are selling. I would look to take profits after this move. Another one of my "pet" stocks, JC Penney, rose +2.3% following news that David Einhorn's hedge Fund Greenlight has taken off its short position in the stock. My/clients' positions here are via short put options, happy to let them run.

Out side of the roller-coaster in equities, not a lot else happened overnight. In FX the USD remained choppy. FX positioning will be tested next week with a big line-up of data to be released including US GDP, the FOMC, ECB, BoE and Nonfarm Payrolls.

Having broken near term consolidation to the downside, USDJPY looks set for a move down for a test of the major uptrend line. I expect USDJPY will weaken to 97 or so before resuming its uptrend. A break of this uptrend line would be a major warning sign for Yen bears, Nikkei bulls and risk-on in general (this not my base case but something I am watching). Note that BoJ Governor Kuroda is giving a speech on Monday. If he tells the market that BoJ will be easier for longer than expected, Yen weakness could resume more quickly.

There has been much chatter this week as to who will be the next Fed Chair, following Bernanke's retirement next year. The market had been assuming Janet Yellen was a shoe-in for the role until earlier this week, the Washington Post's Ezra Klein reported that Larry Summers is now the frontrunner for the role! I must admit I feel greater sympathy for Summer's critics, as expressed here and here. The latest from Klein suggests the potential spat that could ensue between the two candidates could render both ineligible. Attempting to quell the debate, the White House has said that Obama has not yet decided and likely wont announce anything until the fall.

So where to from here for equities? The S&P500 so far this year is up +19%. Given long run average annual stock market returns are in the region of 7-10% - and we are heading into August! - one could argue we are well due for a pullback. This is my view in the short term. However when you consider that the market has barely managed a 2% compound annual return since 2000 one could also argue the market has some catching up to do. I am open-minded to this point of view over the longer term. The current S&P500 earnings multiple of 16x is consistent with the long run average (see last Thursday's post) so that doesn't offer much of a clue to future market direction.

So my preference here is to stay long but begin hedging with some index puts / put-spreads. Also if you have a predominantly long equity exposure, there are a few select shorts I am pondering this weekend. Again I don't want to be outright short this market but would be happy to spend some relatively cheap premium on some equity put-spreads.

Looking at the chart of the S&P (below): the shorter term green up-channel worked well...until it didn't. Of greater relevance now is the longer term purple trend channel which is again posing some upside resistance. For all of the reasons I posted on 25th July I think the path of least resistance short term is downward.

Another factor that causes me to be cautious on this market short term - the Homebuilders sector. This sector has shown strong leadership throughout the rally but has been trading sideways to down for the past couple of months (see chart below). Given how integral the housing sector is to the overall economic recovery in the US it makes intuitive sense that this sector should lead the market. Now the canary in the coal mine perhaps? Worth at least paying attention to I think.

So given my near-term caution, here is one short-term downside trade I am pondering in particular:

Buy puts on Google. Now look, I love this company and from a fundamental perspective it ticks most every box you look for as an investor. But as a trader, the technical picture argues for a short term correction. It looks to me to have completed an Elliot 5 waves up and with a double-top against declining momentum I think such a correction will be big enough to play for the downside move. (The other thing playing against GOOG is it remains the most owned stock by the hedge fund community...a bit like Apple was when it was $700. The recent earnings disappointment could see some of these guys look bail out). I would target a ~10% move to the downside to $800-ish initially.

That's about all for now. I am on a business trip over the next week so it will be at least a week or so before this page next gets updated. Until next time...